VALUATION CA Bhavik Shah 16 May 2015

VALUATION CA Bhavik Shah 16 May 2015

Presentation Overview Valuation Concept Purpose of Valuation Principal Methods of Valuation Net Assets Value (NAV) Method Price to Book Multiple (P/B) Method Price Earnings Capitalisation (PECV) Method Enterprise Value/ EBITDA Multiple (CCM) Method Discounted Cash Flow (DCF) Method Market Price Method Judicial Pronouncements Conclusion

Valuation Concept Value-Price Value varies with situation Not an Exact Science Subjective More of an Art Date Specific

Purchase / Sale of Business Merger/ Demerger Private Equity Buyback of Shares Test of Impairment Why Valuation? IPO/ FPO Family Separation Litigation PPA Regulatory Approval Portfolio Value of Investments

Steps in Valuation Obtaining Information Data analysis & review Discussion with the management of the company Selection of method Conducting sensitivities on assumptions Assigning weights Recommendation Reporting

Sources of Information Historical data such as audited results of the company Management Discussion and Industry Overview Future projections Stock market quotations Representation by the management Data on comparable companies Market surveys, news paper reports

Analysis of Company SWOT Analysis Profitability Analysis- Past and vis-à-vis industry Analysis of P&L Ratios Operating margins EBITDA margins PBT margins Expense ratios Balance Sheet Ratios Quick Ratio/ Current Ratio Turnover Ratios Liquidity Ratios Debt Equity Ratio of Company & Industry

Principal Methods of Valuation Asset Based Approach Net Assets Value Price to Book Multiple Earning Based Approach Earnings Multiple Method Discounted Cashflow Method (DCF) Market Based Approach Market Price

Common Adjustments Following adjustments may be called for: Investments Surplus Assets Auditors Qualification Preference Shares ESOPs / Warrants Contingent Liabilities Tax benefits Findings of Due Diligence Reviews

NAV The Value as per Net Asset Method is arrived as follows: Total Assets excluding Miscellaneous expenditure & debit balance in Profit & Loss Account Less: Total Liabilities Net Asset Value Share Capital Add: Reserves Less: Miscellaneous Expenditure Less: Debit Balance in P&L account Net Asset Value OR

NAV An Example NET ASSETS METHOD (INR lacs) Particulars Net Fixed Assets XYZ Ltd. 1,000 Current Assets 2,450 Current Liabilities (1,565) Net Current Assets 885 Investments 500 Deferred Tax Liabilities (100) Loan Funds (930) Net Assets Value 1,355 Adjustments: Add: Appreciation in the value of Investment 350 Less: Preference Share capital (150) Less: Contingent Liabilities (20) Adjusted Net Assets 1,535 No. of Equity shares (FV - INR 10 each) 9,00,000 Value per Share (INR) 171

Issues in NAV Method Book value may not reflect the true value of assets Earnings potential ignored Profit generating Intangible assets could be understated Brand Patent Value of Human Resource not captured

Price/Book Value Multiple The Price/Book Value Multiple of Comparable Company is arrived as follows: STEP 1: STEP 2: STEP 3: Weighted Average Market Price Divide by: Value per share as per Net Assets Value as calculated in the previous slide Price/Book Value Multiple

Price/Book Value An Example P/B Multiple Method (INR lacs) Particulars Net Fixed Assets XYZ Ltd. 1,000 Current Assets 2,450 Current Liabilities (1,565) Net Current Assets 885 Investments 500 Deferred Tax Liabilities (100) Loan Funds (930) Net Assets Value 1,355 Adjustments: Add: Appreciation in the value of Investment 350 Less: Preference Share capital (150) Less: Contingent Liabilities (20) Adjusted Net Assets 1,535 No. of Equity shares (FV - INR 10 each) 9,00,000 Net Asset Value per Share (INR) 171 P/B Multiple 3 Value per Share (INR) 512

Earnings Multiple Method Commonly used Multiples: Price to Earnings Multiple Market Cap/ PAT Enterprise Value to EBITDA Multiple Enterprise Value/ EBITDA

Price Earnings Capitalization Method (PECV) - Parameters Maintainable Profits Appropriate Tax Rate PE Multiple

Maintainable Earnings Based on past performance and/ or projections Elimination of Material non-recurring/ non operational items Adjustment if Capacity is under-utilized or recently added Profits of various years averaged (simple or weighted)

Multiples Multiples to be applied represent the growth prospects/ expectations of the Company Factors to be considered while deciding the multiple: Past and Expected Growth of the Earnings Performance vis-à-vis Peers Size & Market Share Historical Multiples enjoyed on the Stock Exchange by the Company and its peers

PECV Example CALCULATION OF ADJUSTED PBT (INR Lacs) Particulars 2013-14 (A) 2014-15 (A) 2015-16 ( E ) Reported Profit before Tax 540 780 910 Less: Non recurring Income Dividend Income 340 300 300 Profit on sale of Fixed Assets 10-120 Profit on Sale of Investments 50 100 - Interest on Income tax refund - 40 50 Interest Income 10 18 30 Total Non recurring Income 410 458 500 Add: Non recurring Expenditure Loss on Sale of Fixed Asset - 10 - VRS paid 10 15 20 Others 4-2 Total of Non recurring Expenditure 14 25 22 Adjusted PBT 144 347 432 Add: Interest 165 113 56 Add:Depreciation 79 75 70 Adjusted EBITDA 388 535 558

PECV Example (CONTD...) Price Earnings Capitalisation Value Method Particulars ABC Ltd. (INR Lacs) Adj. PBT Weight Product 2013-14 144 0-2014-15 347 1 347 2015-16 432 1 432 Total 2 779 Maintainable PBT 390 Tax Rate 34.61% 135 Maintainable PAT 255 PE Multiple 15 Capitalised Value of Business 3,821 Adjustments Add: Value of Investments 850 Less: Contingent Liabilities (20) Add: Deferred Tax Liabilities (100) Less:Preference Share Capital (150) Adjusted Earning Value 4,401 No. of Equity shares (FV - INR 10 each) 9,00,000 Value per Share (INR) 489

Enterprise Value / EBITDA Multiple Method Determination of Maintainable EBIDTA. EV/EBITDA Multiple Not affected by the pattern of Funding adopted by Company/ Comparable Companies

EV/EBITDA Example EV/EBITDA Multiple Method (INR Lacs) Particulars ABC Ltd Adj. EBITDA Weight Product 2013-14 388 0-2014-15 535 1 535 2015-16 558 1 558 Total 2 1,093 Maintainable EBITDA 547 EV/EBITDA Muliple 9 Enterprise Value 4,919 Adjustments: Add: Value of Investments 850 Less: Contingent Liability (20) Less: Loan Funds (930) Less:Preference Share Capital (150) Adjusted Equity Value 4,669 No. of Equity Shares (FV - INR 10 each) 9,00,000 Value per Share (INR) 519

Issues in PECV / CCM Method Valuation of: Loss making companies Start-up companies Finite life project companies Ignores time value of money Calculation of Maintainable Profits Adjustment for non-operating / non-recurring items Finding listed comparable companies Difficulty in obtaining comparable multiples Effective tax Rate in PECV Method

Discounted Cash Flow (DCF) Values a business based on the expected cash flows over a given period of time. Involves determination of discount factor and growth rate for perpetuity Value of business is aggregate of discounted value of the cash flows for the explicit period and perpetuity

Discounted Cash Flow (DCF) Considers Cash Flow and Not Profits Cash is King Free Cash Flow ( FCF ) FCF to Firm FCF to Equity

DCF Parameters Cash Flows Projections Horizon period Growth rate Discounting Cost of Equity Cost of Debt Weighted Average Cost of Capital ( WACC )

Cash Flows Business Plan Capital Expenditure Business Cycle Depreciation Amortization Working Capital Tax

DCF Projections Factors to be considered for reviewing projections: Industry/Company Analysis Dependence on single customer/ supplier Installed capacity Existing policy/ legal framework Capital expenditure increasing capacities Working capital requirements Alternate scenarios / sensitivities

Cost of Equity In CAPM Method, all the market risk is captured in the beta, measured relative to a market portfolio, which at least in theory should include all traded assets in the market place held in proportion to their market value Ke = (Rf + ( x Erp)) Where, Ke = Cost of Equity Rf = Risk free return Erp = Equity risk premium = Beta

Cost of Debt Kd = (Int x (1-t)) Where, Kd = Cost of Debt Int = Average Interest Rate t = Marginal rate of tax

DCF Discounting Rate Weighted Average Cost of Capital (WACC) D E WACC = x Kd + x (D + E) (D + E) Ke D = Debt E = Equity Kd = Post tax cost of debt Ke = Cost of equity

DCF Terminal Value Terminal Value is the residual value of business at the end of projection period used in discounted cash flow method TERMINAL VALUE LIQUATION APPROACH MULTIPLE APPROACH STABLE GROWTH APPROACH

The Final Value Under the FCF to the firm approach - The Value is the summation of: PV of the FCF to Firm during the horizon period PV of the residual value PV of the tax benefit on the WDV of the assets, 80IA, 10A/10B sales tax, etc. beyond the horizon period Market value of the investments and other non-operating/ surplus assets (net of tax)/ surplus cash as at the valuation date Adjustment for contingent liabilities (net of taxes)

DCF When to use? Most appropriate for valuing firms: Limited life projects Large initial investments and predictable cash flows Regulated business Start-up companies

DCF Example (INR Lacs) Particulars 2015-16 2016-17 2017-18 Perpetuity Operating PBT 432 518 596 Add: Interest 56 44 46 Depreciation 70 80 86 Total Inflows 558 642 728 Less: Outflows Capital Expenditure 45 45 45 Incremental Working Capital 20 30 30 Tax 158 182 208 Total Outflows 223 257 283 Free Cash Flows (FCF) 335 385 445 Cash Flow for 2019-20 445 Growth Rate 5% Capitalised Value for Perpetuity 5,838.15 Discounting Factor 13.00% 0.88 0.78 0.69 0.69 Net Present Value of Cash Flows 296 301 308 4,046 Enterprise Value 4,952 Less: Loan Funds (930.0) Less: Preference Share Capital (150.0) Less: Contingent Liability (20.0) Add: Value of Investments 850 Adjusted Value for Equity Shareholders 4,702 No of Equity Shares 9,00,000 Value per Share (FV INR 10) 522

Issues in DCF Method Issues in forecasting cash flows Estimation of Discounting Factor Parameters Risk Free Rate Beta Market Return Debt Equity Mix Terminal Growth rate Pre Money or Post Money Valuation

Market Price Approach Evaluates the value on the basis of prices quoted on the stock exchange Thinly traded / Dormant Scrip Low Floating Stock Significant and Unusual fluctuations in the Market Price It is prudent to take weighted average of quoted price for past 6 months Regulatory bodies often consider market value as important basis Preferential allotment, Takeover Code

Market Price Method Example Market Price Method Months Volume Turnover November 2014 16,95,000 7261,42,620 December 2014 14,95,000 5849,22,726 January 2015 15,02,560 7810,96,596 February 2015 13,26,395 9112,16,380 March 2015 11,85,424 8185,98,438 April 2015 10,57,403 4791,13,336 Total 82,61,782 43010,90,096 Value per Share (INR) 520.60

Issues in Market Price Method Market price mat not capture intrinsic value Thinly traded / Dormant Scrip - Low Floating Stock Unusual fluctuations in Market Price

Selection of Methods SITUATION Knowledge based companies Manufacturing Companies Brand Driven Companies A Matured Company Investment / Property Companies Company going for Liquidation NBFC / Banks APPROACH Earning / Market Earning / Market / Asset Earning / Market Earning / Market Asset Asset P/B Multiple Generally Market Approach is used in combination with other methods or as a cross check

Reaching a Recommendation Methods throw a range of values Consider the relevance of each methodology depending upon the purpose and premise of valuation Mathematical weightage Professional judgment Subjective Value

Fair Value An Example Method Value per Share (INR) Weight Product (INR) Net Assets Method 171 1 171 P/B Multiple 512 1 512 Price Earning Multiple Method 489 1 489 EV/EBIDTA Multiple Method 519 1 519 DCF Method 522 1 522 Market price Method 521 1 521 Total 6 2,733 Fair Value per share (INR) 455.49

Other Value Drivers Final Value Final Price is a result of negotiations

Some Issues (Common) Relying on Technical Valuer s Report Joint Reports Fairness Opinion by Merchant Bankers Engagement Letter Management Representations Reporting

Judicial Pronouncements Exchange Ratio not disturbed by Courts unless objected and found grossly unfair. Miheer H. Mafatlal Vs.Mafatlal Industries (1996) 87 Com Case 792 Dinesh v. Lakhani Vs. Parke-Davis (India) Ltd. (2003) 47 SCL 80 (Bom) It is fair to use combination of three well known methods viz. asset value, yield value & market value Hindustan Lever Employees Union Vs. HLL (1995) 83 Com case 30SC

Judicial Pronouncements Valuation will take into account number of factors such as prospective yield, marketability, the general outlook for the type of business of the company. Mathematical certainty is not demanded, nor indeed is it possible Viscount Simon Bd in Gold Coast Selection Trust Ltd. Vs. Humphrey reported in 30 TC 209 (House of Lords)

Conclusion Valuers must keep in mind fairness to all stakeholders Many instances of minority shareholders delaying the merger process by challenging valuation Balance needs to be achieved through transparency, fairness and best governance practices